The stock market’s fall into correction mode in February and subsequent sideways trading action isn’t driving bulls to give up the ghost, said analysts at Bank of America Merrill Lynch on Tuesday.
Citing the firm’s monthly survey of fund managers from around the globe, they argued that bulls have been “silenced, not routed” and that risk assets can bounce, though the range between 2,550 and 2,850 for the S&P 500
remains intact. The S&P 500 remains around 6% below the all-time high set above 2,870 in late January, while the Dow Jones Industrial Average
is off around 6.9% from its record.
The amount of cash held by funds jumped in April to 5%, from 4.6%, amid 18-month lows in profit expectations and equity allocations (see chart below). That’s above the survey’s average of 4.5% over the past 10 years and remains a “contrarian buy signal,” the Merrill analysts said.
The survey has yet to show the signs of “true” capitulation by the bulls, with just 13% of managers calling recession likely and only 18% saying the stock market has peaked, the analysts noted. Meanwhile, 40% look for stocks to peak in the second half of this year, while 39% don’t expect the top to come until next year.
Moreover, Merrill Lynch said asset allocators are “still married” to the concept of “TINA”—the acronym for “there is no alternative.” That is the notion that in a low-yield environment, equities remain by far the most attractive option until the yield on the 10-year Treasury note
The “magic number”for the 10-year yield—defined as the level at which managers said they would rotate from equities back into bonds—was seen at 3.6% in March.
The 10-year yield came close to 3% in early February amid worries about a potential pickup in inflation, but then retreated as Treasurys attracted haven-related buying as equities tumbled. Subsequent rounds of geopolitical turmoil—including a potential U.S.-China trade war and tensions over Syria—were credited with pressuring yields, which move in the opposite direction of bond prices. The 10-year-note yield stands just below 2.84%.
The survey did find that expectations surrounding two pillars of the stock market’s 2017 rally—robust earnings and strong global growth—continued to fade.
Earnings expectations appear to have peaked, the analysts said, with the survey showing a net 8% of respondents looking for earnings per share to substantially rise in the next 12 months, down from 35% in February.
Expectations for faster global growth has also declined, with just a net 5% now expecting a stronger economy over the next 12 months—the lowest reading since the U.K. voted to leave the European Union in June 2016.
Bank of America Merrill Lynch’s own macro indicator—which is based on year-over-year changes in inflation expectations, capital expenditure demand, risk appetite, cyclical-versus-defensive sector positioning and equity-versus-bond positioning—remains in “neutral” territory, the analysts said. Macroeconomic conditions appear to have peaked in recent months, they noted (see chart below).
The April survey, meanwhile, did see investors reducing long equity and short bond exposures. They were also increasing allocations to commodities and U.K. stocks while cutting exposure to cyclicals.
Bets on large-cap U.S. and Chinese tech stocks were still viewed by managers in April as the “most crowded” trade. That marks the third month in a row that the long FAANG+BAT earned the distinction. (FAANG+BAT is an acronym for U.S. tech heavyweights Facebook Inc.
and Google parent Alphabet Inc.
and Chinese players Baidue Inc.
Alibaba Group Holding Ltd.
and Tencent Holdings Ltd.
The threat of a trade war, meanwhile, remained the biggest “tail risk” identified by investors for the second month in a row, ahead of worries about central bank policy, market structure and inflation.
Among other notable results:
- • 41% of investors say companies are over-levered, surpassing the 32% peak seen in 2008, while overall a record net 33% think corporate balance sheets are overleveraged.
- • Equity allocations fell to an 18-month low of 29% from net 41% overweight in March, putting the current allocation back at its long-term average.
- • A net 40% of respondents said they were overweight cash, slightly off the 18-month high of 42% in March, but a 1.6 standard deviation above the long-term average.
- • Allocation to commodities rose to 6% overweight, the highest since April 2012, when West Texas Intermediate crude
traded at $105 a barrel.
- • Among investing “styles,” a net 64% of investors expect high-quality stocks to outperform low-quality equities, up form 55% in March.
- • Investors still think gold
is undervalued. Just a net 8% said the yellow metal was overvalued. Respondents have been saying gold is undervalued for the past 15 months, Merrill Lynch noted.